Country Risks and FDI: Empirical Evidence from Latin American Countries

Article excerpt

INTRODUCTION

With sustained news about the slow down in the US economy driven by a multitude of colliding factors, it is increasingly clear that the weakening of the largest economy in the world will be here for some years to come. Global Insight's global overview states that the world economy is enduring the deepest and longest recession of the postwar era, and that the U.S. economy will stabilize in late 2009 and only begin to recover in 2010 (Global Insight, March 2009). Based on this, one cannot help but think that when the United Stated gets the flu, Latin America gets pneumonia; and that a weak economy in the US could mean a reduced outflow of capital through various forms of Foreign Direct Investment (FDI). Since it can be argued that Latin American countries benefit greatly from inward FDI, as noted by the Executive Secretary of the United Nations Economic Commission for Latin America and the Caribbean (ECLAC), the use of FDI is the only way the region could close its economic gap with the rest of the world (ECLAC, 2003). Furthermore, competition for FDI has become fierce among countries that have an explicit interest to be targets for multinational enterprises (MNEs) that seek to diversify their asset base as shown by Doukas and Travlos (1988). This is an attractive proposition for shareholders and supports the theory of corporate multinationalism, especially in the case of US firms expanding into new industry and geographic markets from under-developed countries.

Based on this, it is reasonable to affirm that Latin American Economies are in great peril of seeing sharp decreases in FDI; and gradually become an after-though for North America, and other MNEs that seek to survive the economic downturn. This warning should serve as an early wake up call to Latin American countries to focus on better understanding the motivations of MNEs for distributing their FDI outflows; in concrete terms, what are the factors that drive MNEs to invest into Latin America?

Finding a simple and valid approach to determine the major motivators for FDI is one of the first steps to providing guidance as to what levers need to be pulled in order to make Latin American countries more attractive for capital inflows. This is especially true in a Region where so many variables are constantly in flux; therefore attempting to understand, assess, quantify and compare each country's complexities becomes an extenuating task.

This study aims to propose a simple tool to show the differences in the correlations between various types of country risk and FDI inflow; which would serve as a proxy for determining the drivers of MNEs to invest into a specific region or country. Six Latin American countries are viewed as a single cluster, which provides an aggregate risk profile with data from eight years for all dependent, independent and control variables. All hypotheses proposed were confirmed, providing empirical proof that the overall country risk is negatively correlated to Inward FDI into Latin America. Additionally, each type of country risk tracked by the Economist Intelligence Unit also has a negative correlation to Inward FDI into Latin America; and there are differences in the degree of impact of types of Country Risk on Inward FDI to Latin America.

This study will start by presenting a literature review to outline the main findings regarding both FDI and FDI inflows into Latin America. The hypotheses will then be presented, followed by an outline of the data and method utilized, the empirical results, a short discussion on strategic and policy recommendations and overall conclusions.

LITERATURE REVIEW

Maniam (2007) evaluates the FDI inflows into Latin America; this was done by replicating the Maniam (2005) empirical analysis that was conducted for Asian countries; and explores factors that include incentives and regulations. The results of the study are enhanced by a discussion regarding the contribution of FDI to the region's development. …